To chase this dream of building your home, it’s important to understand how the “VA Guaranty” on “VA Construction Financing” minimizes the risk for the lender. Let’s first define the VA Guaranty. The VA Guaranty binds The United States Department of Veterans Affairs and a lender together for the purpose of reducing the lender’s risk. Lenders are institutional, private enterprise, for-profit, non-government entities, typically a bank or mortgage company. Provided the loan package meets all the VA loan underwriting guidelines, the contract between the VA and the lender says that the VA will protect the first 25% of the loan balance against loss, should the borrower fail to repay the loan.
If the borrower defaults on the payments, the lender will foreclose on the house and may suffer a loss when the home is resold. If the risk was properly measured in underwriting, the loss will hopefully be less than 25% of the original loan balance when the home is resold. In this case, the lender will have not suffered any financial loss and the mechanism between the VA and the lender will have performed as planned. The VA Loan Guaranty is paid for from an “insurance pool” funded by the “VA Funding Fee.” This is an insurance premium or fee that is added to the loan balance, and directly paid to the VA from the lender after funding. Because it is part of the loan balance, it is paid for over the life of the loan by the borrower.